Luna has a flexible investment approach enabling us to invest in most types of regulated securities. One important investment vehicle we hold across client portfolios is closed ended funds (more commonly known as investment trusts).
Ongoing consolidation amongst our peer group of investment managers resulted in an increasingly centralised investment approach. These firms run larger pools of capital, making it difficult for them to hold anything other than the largest investment trusts. We believe this restriction is a drawback for investors of those firms. In this Luna Perspective we will discuss why we believe holding investment trusts adds value to our investment process.
Investment trusts are listed on stock exchanges and trade daily when stock markets are open. They are one of the oldest types of investment vehicles; the Foreign and Colonial Investment trust was established in 1868. Trusts are managed by professional fund managers who invest in a diverse range of assets such as equities, bonds, and property, with the aim of generating a return for their investors. Investment trusts typically have a fixed number of shares in issue, which means that the fund size is fixed. This makes investment trusts more stable and less prone to liquidity issues compared to open-ended funds (more commonly known as unit trusts).
We highlight a number of the benefits of holding investment trusts:
Discounts and Premiums:
Investment trusts can trade at discounts or premiums to their Net Asset Value (NAV). When an investment trust is at a discount this means that investors can buy shares in an investment trust at a price that is less than the value of its underlying assets. This provides investors with an opportunity to profit from the difference between the share price and the NAV. Over the last year, the volatility in markets has pushed some trusts to discounts, providing opportunity for the discount to return closer to the NAV over time.
Some managers run both an investment and unit trust, such as Lindsell Train. Their Finsbury Growth Trust moved to a discount to NAV recently, providing the opportunity to switch to the investment trust version of their UK strategy. Occasionally, trusts can trade at a premium to the NAV; recently the abrdn Equity Income Trust moved from a discount to a premium and we used this as an opportunity to sell and move on to a more attractively valued asset.
Leverage:
Investment trusts can borrow money to invest in assets, which can enhance returns if employed skilfully by the manager. This is because the borrowed money can be invested in assets that generate a higher return than the cost of borrowing. Several trusts took advantage of the low interest rate environment to refinance their borrowings and lock into lower rates. This should be a benefit in the future for any trust that did this. This is not possible in open-ended funds, which are subject to restrictions on borrowing.
Liquidity:
Investment trusts are listed on stock exchanges, which means that they are traded like ordinary shares. An investment trust will never be closed to redemptions. For example, there have been several occasions property unit trusts have been closed and investors cannot withdraw their money.
Access to different asset classes:
Investment trusts provides clients with the opportunity to access a wider range of asset classes, including private equity, infrastructure investments, real estate, and specialist sectors. This delivers significant advantages including enhanced diversification, potentially higher returns, and allow investors to participate in asset classes that are typically not available through open-ended funds.
Revenue Reserves:
Another unique feature of investment trusts is the ability to accumulate revenue reserves over time. Revenue reserves represent the retained income generated by the trust from dividends, interest, and other income sources, which are not distributed as dividends to shareholders immediately. Instead, these reserves are retained within the trust to be used in the future.
The ability of investment trusts to accumulate revenue reserves can provide benefits such as smoothing dividend payments, potential dividend growth, and as a buffer against challenging market conditions. For example, the Lowland Investment Trust has grown its dividend at 6.8% per annum since 1992 (source: Janus Henderson Investors).
Board Oversight:
Investment trusts have a board of directors who are independent from the fund manager. This provides an additional layer of oversight and governance. The board of directors is responsible for ensuring that the fund manager is following the investment strategy and managing the fund in the best interests of investors.
Fixed pool of assets:
The fund manager is not distracted by investor money flowing in or out in the short term. This is quite different from an open-ended fund gathering assets to increase the fund size. We feel this is an increased alignment of interests with that of the shareholders.
Aside from the benefits mentioned already, there is evidence of investment trusts delivering superior returns vs their open-ended counterparts and doing so at a lower cost. In general, investment trusts tend to have lower annual management fees than open-ended funds. This is because investment trusts independent board of directors have responsible for overseeing the management of the fund and negotiating fees with the fund manager. From a performance perspective research conducted by the Association of Investment Companies (AIC) found that over the last decade, investment trusts have outperformed open-ended funds in eleven out of fourteen investment sectors. Past performance is not a reliable indicator of future results.
In summary, some trusts may be more volatile in certain conditions owing to widening discounts and the use of gearing, but we believe the many benefits outweigh any risks. Over the long-term trusts tend to outperform open-ended funds due to the structural advantages highlighted. We believe they are incredibly useful and important vehicles to hold in client portfolios.
As ever, if you have any questions please get in touch on 0161 518 3500 or email a member of the team.
The content in this publication is for your general information and use only and is not intended to address your particular requirements. Articles should not be relied upon in their entirety and shall not be deemed to be, or constitute, advice. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No individual or company should act upon such information without receiving appropriate professional advice after a thorough examination of their particular situation. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts. Levels and bases of, and reliefs from, taxation are subject to change and their value depends on the individual circumstances of the investor. The value of your investments can go down as well as up and you may get back less than you invested. Past performance is not a reliable indicator of future results.